Cost of Dropping Citizenship Keeps U.S. Earners From Exit

Those who expatriate must renounce their citizenship to avoid U.S. taxes and navigate several sets of Internal Revenue Service rules when setting up a foreign corporation. Photographer: Andrew Harrer/Bloomberg

Feb. 22 (Bloomberg) -- Tax attorney Seth Entin has fielded
about a dozen calls since Jan. 1 from individuals or companies
thinking about exiting the U.S. or moving assets abroad.

“I don’t think I’ve ever gotten more calls in this
particular area,” said Entin, who focuses on international tax
at Miami-based Greenberg Traurig LLP. “A fair amount of the
time I wind up telling people that it’s easier said than done,
and if they try to do it they may wind up in a worse
situation.”

Exit taxes and other costs make it prohibitive for most
high-income taxpayers and small-business owners to leave the
U.S., though they may want to go because of higher taxes at the
federal level and in states such as California. Those who
expatriate must renounce their citizenship to avoid U.S. taxes
and navigate several sets of Internal Revenue Service rules when
setting up a foreign corporation.

A high-income couple worth $100 million whose assets have
$50 million in gains may have a $10 million tax liability if
they decided to leave this year, said Henry Christensen, a
partner at Chicago-based McDermott Will & Emery who manages the
firm’s international private client practice.

While the number of people giving up their U.S. passports
has been higher in the past few years than in the previous
decade, the numbers are a small portion of the population. About
932 people gave up their U.S. citizenship in 2012, IRS data
show. That compares with 1,781 in 2011 and 742 in 2009.

Worldwide Income

The U.S. taxes citizens on their worldwide income even if
they live in another country. That’s why people give up their
passports to avoid the IRS’s reach.

Top earners will incur higher taxes this year. Congress
raised the maximum tax rate to 39.6 percent from 35 percent on
taxable income exceeding $400,000 for individuals and $450,000
for married couples.

The increase is coupled with higher levies on capital gains
and dividends for top earners of as much as 23.8 percent
compared with 15 percent in 2012. States including California
also have raised taxes on top earners. California’s tax on
income of $1 million or more was boosted to 13.3 percent, the
highest in the nation.

The U.S. government generally imposes an exit tax on high
earners to discourage them from expatriating as a way of
avoiding taxes.

$2 Million

For 2013, individuals with a net worth of more than $2
million, or with average annual income taxes exceeding $155,000
for the past five years, must pay taxes on the value of assets
such as homes and stocks as if they were sold the day before
they expatriated, according to the IRS. They can benefit from an
exclusion of $668,000.

“If someone was timing an exit, you would want to do it
before your assets appreciated,” said Suzanne Shier, director
of wealth planning and tax strategist at Chicago-based Northern
Trust Corp.

Eduardo Saverin, the billionaire co-founder of Facebook
Inc., renounced his U.S. citizenship before the company’s
initial public offering last year to reside in Singapore.
Saverin also had citizenship in Brazil, where he was born. He
said at a Feb. 20 conference organized by The Wall Street
Journal in Singapore that he didn’t renounce his U.S.
citizenship for tax reasons.

34 Countries

The U.S. ranked 20th last year of 34 countries on a list of
top statutory personal income tax rates at 41.9 percent,
according to the Organization for Economic Cooperation and
Development. The ranking considered federal, state and local
levies, said Maurice Nettley, head of tax statistics in the
center for tax policy and administration at the OECD. Denmark
led the ranking at 60.2 percent while the Czech Republic was
34th at 15 percent.

A family’s wealth may still be subject to U.S. taxes after
expatriation, which is another deterrent to exiting, Shier said.
If parents move to another country and leave money upon death to
their children -- who remained U.S. citizens -- levies similar
to the estate tax apply, Shier said.

Some deferred compensation plan money and irrevocable non-grantor trusts may be taxed when distributions are made in the
future, she said.

The exit tax keeps people from giving up their passports
and also limits how much time they can spend in the U.S. after
they leave without having to pay further taxes, said Entin of
Greenberg Traurig. Several sets of IRS rules can have severe tax
consequences for those setting up a business outside of the U.S.

Several Layers

If the owner of a limited liability company establishes a
foreign corporation conducting business in the U.S., it may have
to pay several layers of U.S. income tax. Those include a top 35
percent corporate tax, a 30 percent so-called branch profits tax
and as much as 43.4 percent tax on non-qualified dividends
distributed to a shareholder, Entin said.

That would, in a worst-case scenario, bring after-tax
earnings on $100 to $25.80, excluding state taxes, he said.

By comparison, if executives kept the business in the U.S.
and participated in it, they would pay a top rate of 39.6
percent on $100 of earnings, leaving them with $60.40, he said.

“That’s the most common show-stopper I encounter,” he
said. “There are real situations where it works and you can get
a real benefit, but there are a lot of hoops and vetting to get
through.”

Higher Rates

It’s too early to tell whether higher tax rates Congress
passed for this year along with added levies from the health-care law will motivate more top earners to turn in their
passports, said Shier of Northern Trust.

In the past most clients who renounced citizenship were
green-card holders, dual citizens or those who had been living
abroad for many years, Christensen said.

While people are talking about moving because of higher
taxes, most are considering crossing state borders from high-tax
states such as California or New York to places like Texas and
Florida that don’t have state income taxes, Christensen said.

“It’s really not worthwhile for most people to give up
their passports,” he said.